Running a business is a lot of work, and you deserve a paycheck! Whether you're just getting started or need to do a periodic check-in on your pay, owner's compensation is important. However, because of this, a lot of small business owners don't know how to get it right.
At CSI Accounting & Payroll, we've worked with small businesses for over 50 years. One of the most common things that newer business owners ask about is how to pay themselves. Here are the FAQs we hear most on this topic:
- How should I take the money? Which method?
- When should I start paying myself? How often should I review my pay?
- How much should I pay myself? How much is too much or too little?
What is the Best Method of Compensation?
When considering taking out owner's compensation, you should decide the best method to do so. You can either pay yourself a salary or take an owner's draw. This is based quite a bit on your entity tax type.
Salary
If you own an S or C Corporation, you may be required to take a salary. The benefits of taking a salary are that tax withholdings and benefit payments will automatically be deducted.
- S Corporations
If you perform essential functions for an S-Corp, you need to pay yourself a salary that's comparable to what professionals in similar roles are paid. With an S-Corp, the tax liability is distributed to the shareholders. You can also receive an additional distribution on the company's profits, which is not subject to payroll taxes.
- C Corporations
Much like an S-Corp, if you are heavily involved in managing the C-Corp, you're considered an employee and must pay yourself a salary. Since a C-Corp is responsible to pay its own tax liability, if you take a distribution (dividend) from the corporation, you will also be responsible for paying income taxes on that distribution. This is referred to as the C-Corp double taxation.
- Sole Proprietorships
As an owner of a sole proprietorship, you're not allowed to take a salary and may only take owner's draws.
- Partnerships
Partners in a partnership are not allowed to be on a company payroll, but they're allowed to take a "salary" through guaranteed payments. Guaranteed payments are treated similar to owner's draws because they are taxable on a personal tax return.
Owner's Draw
- S Corporations
- C Corporations
- Sole Proprietorships
- Partnerships
When Should I Start Getting Compensated?
It's common for small business owners to not take any compensation during the first few years of being in business. During this time, you should start to see patterns of high growth and are reinvesting profits back into the business.
Don't wait too long to start paying yourself though! Without factoring in your compensation, your books will not be entirely accurate, and you will not be able to make informed business decisions.
Here are three signs that you're ready to pay yourself:
- You have consistent revenue patterns for the past 3-6 months
- You have a positive outlook for continued revenue into the next 12 months
- Your have generated consistent profits for the past 3-6 months
All three points should be true before you start paying yourself owner's compensation.
What is the Right Amount of Compensation?
When you start a company, you perform most - if not all - of the roles. How much should you pay yourself for your hard work?
There's no set formula for this. Ultimately, you need to find the happy medium between paying yourself enough to avoid potential IRS issues and paying yourself so much that you're taking away from the business's growth potential.
In the Beginning
A good way to start is to create a personal budget for yourself. What does it take to pay your bills and maintain your lifestyle? You'll want to stay on the modest side of that for a while.
This number is one that your accountant can help you with as well, since they know your finances inside and out. At CSI, since we don't work with many startups, most clients who come on board already have owner's compensation in place. However, we can see if the number works for you and your business, and we can help adjust it over time.
Periodic Check-Ins
Later on, you should review your compensation regularly to make sure your personal cut of profits grows with the company. If you're a new business, review your pay every quarter. If you're an established business, check annually. A major way to know what you should be making is by simply comparing your pay against the pays of others in your same role and industry.
Are you happy with what you're making? You are your business's most essential worker, so your compensation should be treated as a critical part of your retention.
If you're worried about overcompensating yourself, just keep an eye on these two things: your business's bank account and the amount you pay in withholding taxes. If your business bank account can't cover its expenses, or you feel you're paying too much in withholding taxes, it might be a sign you need to lower your compensation.
Ready to learn more?
Owners need to pay themselves eventually! Now you should know which method you should use, when you should start taking compensation, and how much you should pay yourself. However, if you still have questions, an accountant is the perfect person to ask.
Did you know that monthly accountants are the financial advisors of the business world? Their knowledge of your books helps them offer you advice based on data in real-time. What would financial clarity help you achieve?
If you're interested in monthly accounting, why not consider CSI Accounting & Payroll? We've been helping small businesses at many phases of their journeys for more than 50 years. Click the button below for a free consultation to see if we can be a good fit for your business.
Not ready to talk? That's okay! First, learn more about how an accountant can help you start a small business.
